Fed's fear and loathing is unproductive

CBS.MarketWatch.com

LOS ANGELES (CBS.MW) -- The current tone of rhetoric among economists and Fed officials reads like a Hunter S. Thompson tract.

"Inflation comes from
inflationary monetary policy, not from within the economy."
Michael J. Bazdarich

Instead of "Fear and Loathing on the Campaign Trail," we have fear and inanity in economic policy.

Consider the following pearls of conventional wisdom: William McDonough, vice chair of the Fed's Open Market Committee, worries that a sudden decline in productivity would unleash accelerating inflation. See story.

CBS MarketWatch columnist Dr. Irwin Kellner frets that productivity growth is overstated because the government's data do not include all the unpaid overtime he and his peers are working. See column.

Meanwhile, the Fed hikes short rates yet a third time in an attempt to quell the economy's "robust" growth.

Inflation comes from inflationary monetary policy, not from within the economy. Rapid growth is inflationary only if it is being driven by overly-expansionary monetary policy. What constitute inflationary monetary policy are such factors as excessive growth in the money stock or interest rates that are held at artificially low levels.

Throughout this decade, the underlying rate of growth in the M2 money stock has been 5 percent or less. Never in world history has 5 percent money growth caused inflation problems, and it is not going to now.

No reason for inflation to rise if productivity declines

What about the statements on productivity growth? Faster productivity growth leads to faster economic growth, and vice versa. However, if Fed policy is held at a noninflationary stance, there is no reason for inflation to pick up should productivity growth suddenly decline. Instead, economic growth subsides when productivity growth does, with no impact on inflation.

Ironically, when inflation picked up for real in the late-1960s, it did so during a period of even faster productivity growth than we are witnessing now. Despite that rapid productivity growth, the Fed then tried to induce even faster economic growth, and inflation ensued. That is not happening now.

Undercounting hours worked

What about hours being overcounted? Well, if hours of salaried workers are being undercounted, that overstates the level of productivity, but it has no impact on labor costs, because it overstates hourly compensation by an exactly equal proportion.

Unit labor costs are the ratio of output per hour (productivity) to compensation per hour. Undercounting hours worked leaves this ratio unaffected. If the columnist's hours are being undercounted, he's got a beef with his boss, but no problem for inflation.

A last inanity concerning productivity has economists arguing whether faster productivity growth is or isn't due to the presence of computers in the workplace. This debate completely misses the point.

Rapid productivity growth is due to rapid gross domestic product growth. Rapid GAP growth is accruing from manufacturing GAP, which the data show growing at 8 percent, while hours worked are declining. Rapid factory GAP growth, in turn, is coming straight from high-tech, where output is growing 30 to 40 percent per year, even with no increase in hours worked.

In other words, whether or not the presence of computers in the workplace has boosted productivity, the production of computers certainly has.

Prices falling in high-tech sector

The high-tech sector is accounting for whatever "robust" growth this economy is experiencing. That sector is also pushing down its prices at a dizzying rate. It is ludicrous for the Fed to be worried about "inflationary" growth in a sector where prices are falling 30 percent annually, but that is the state of policy at the Board.

Until sanity returns to Constitution Avenue, we will have to live with Fed rates designed to kill the "inflationary" implications of "deflationary" growth. What we won't have to live with is rising inflation.

Fortunately, investors on the Street have begun to wise up to these facts of life. Even with economists and the Fed still fretting, bond yields have dropped about 30 basis points in recent weeks. The odds are that the markets have turned the corner on the latest inflation scare. More on this next week.

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